Skanska AB (SKSBF) CEO Anders Danielsson on Q3 2019 Results – Earnings Call Transcript – Seeking Alpha

Skanska AB (SKSBF) CEO Anders Danielsson on Q3 2019 Results – Earnings Call Transcript  Seeking Alpha

Skanska AB (OTCPK:SKSBF) Q3 2019 Earnings Conference Call November 7, 2019 4:00 AM ET

Company Participants

André Löfgren – Senior Vice President, Investor Relations

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Anders Danielsson – President and Chief Executive Officer

Magnus Persson – Executive Vice President and Chief Financial Officer

Conference Call Participants

Tobias Kaj – ABG Sundal Collier Holding

Stefan Andersson – SEB

Niclas Hoglund – Nordea Markets

Albin Sandberg – Kepler Cheuvreux

Simen Mortensen – DNB Markets

André Löfgren

Okay, people. It’s 10 A.M., so it’s time to start the press conference. I would like to welcome you all here to this 9-month report presentation and a special welcome to all of you guys who made it here to our headquarters here in Stockholm. But of course, also, a big welcome to all of you on the web.

You will all be able to ask questions after the presentation. We will start hearing the audience, but then also move over to the phone conference. The presentation, it will be held by our CEO, Anders Danielsson; and also our CFO, Magnus Persson.

And with that, I leave it to you, Anders.

Anders Danielsson

Thank you, André. Good morning. Before I start through the figures, I want to look at the picture here, it’s the Visionary in Prague, a project development we have done and also completed. Of course, it’s a WELL Building gold certificate and also LEED Platinum, the highest standard in that scale.

But first, highlights of the quarter here. It’s solid. It’s a good third quarter. We continue to improve the profitability in the Construction stream, which we have done for some quarters now. And I expect that to continue over time as well. So for me, it’s really encouraging to see that the strategic action we took in early 2018 is starting to pay off quarter-by-quarter. Very important. And it’s also very good to see that we continue to perform on a very high level when it comes to project – Commercial Project – Property Development, and also in the Residential Development is on a high level.

The operating margin in the Construction stream in the first 9 months is 2.3%. We have 2.8% in the quarter, which is a really big step from last year. We have the return on capital employed in the Project Development is also above our target of 10%. So we continue to deliver on a high level. Return on equity on a rolling 12 basis is also above our target. We have a target of 18% when it comes to return on equity, and now we have a rolling 12 of 21.6%.

The market, I come back to the market later on in more detail, but overall, we can say slightly weaker market. But in overall, is – the market outlook is unchanged. So I’ll come back to the details later on here.

Going to each stream here. The revenue is SEK 117 billion first 9 months here in Construction stream. We have an order booking of SEK 96.8 billion, which gives us a book-to-build of 91% on a rolling 12 basis. And I can see that that’s quite natural for me because we are taking orders in the market where we perform, especially in the Nordic regions and we also have a good order intake in the United States and weak – slightly weaker in Europe. That, overall, helped the backlog.

Operating income, SEK 2.7 billion, and we have operating margin again of 2.3% for the first 9 months. The underlying profitability continues to improve. We can see a big improvement in Europe. We also can see gradual improvement in the United States. At the same time, as we continue to perform on a high level in the Nordic regions.

And we are – our strategic action, one of the main focus is profit before volume. And we are more selective when it comes to which project we should bid for, and we have to make sure that we bid for projects that we can see a profitable future. And that means that we need to see that we have a competitive advantage. We need to see that we have the resources, the right competence in place to go for. That’s the foundation for running a profitable construction operation.

Residential Development, we have revenue of SEK 7.2 billion. We sold quite a bit higher on a number of homes during the first 9 months here. And we also started less homes than compared to the same period last year. And that’s quite natural for me because you can also see that the last year, we started more projects that we sold – than we sold that, of course, can continue over time. So now we are more in the balance between the home we started and homes we sold.

Operating income, we have operating margin 11.4%, also above our target. We have a target here of 10%. And we have return on capital employed, slightly below our target of 10%, 9.5% here on a rolling 12 basis. And then we can see a minor improvement in the Swedish residential market. But it’s – I expect it to be quite slow over time, at least for the coming 12 months. But we can see that the buyers are coming back to the market. We can see also a change in the behavior amongst the buyers. There’s a strong trend that they want to buy and sell in the same market, which means that they are buying closer to project completion. That’s a strong trend, and I expect that to continue over time.

And the good thing for us is, of course, that we have the financial capability to start projects with a – with the lower sales rates. And we’re doing that. We are doing that in locations where we believe the market is good and we have the right product as well. And we also, of course, have – as we have been talking about the last few quarters, a good mix in the portfolio. So we have both more affordable housing, we have BoKlok, we have also rental apartment that we invest in here, especially here in Sweden. So we are adapting to the somewhat changed behavior in the market there.

Commercial Property Development, again, a very strong quarter. And it’s really good to see how we managed to perform over time here. We have an operating income of slightly above SEK 2 billion for the first 9 months, and a gain on sale of SEK 2.8 billion, which is really strong. Return on capital employed, 11% also above our target of 10% on a rolling 12 basis. We have 46 ongoing projects. So there is a lot of future value in the ongoing projects, of course, and that corresponds to investment of SEK 31.5 billion upon the completion of those projects.

The occupancy rate versus the completion rates is well in balance, around 60%, which is also important that we have a balance between those. And we actually start – managed to start 10 new projects in the first 9 months here in the company. And the leasing is really – continually to be really strong, 261,000 square meters leased. You can see the comparison – above the comparison period last year.

And there we can see a continued very strong interest of our products, both when it comes to investors. We have a very low interest rate in our market. So it’s really attractive for all the capital that’s out there to invest in our commercial development projects. And we also see – continue to see strong interest amongst the tenants, and we can show that by the leasing activity, of course.

The order situation in Construction is we have a book-to-build of 91%. You can see here, over time, the rolling 12, how it develops. But I would say, we have a solid and confident backlog in our books. I can also see that that’s one of the reasons that we’re fading out the projects that has the so-called dead revenue or that we have taken the losses in previous quarters. And we can see that those are fading out as – pretty much as planned. So that’s encouraging. At the same time that we take on new projects that we see higher profitability in.

Order bookings, if you look down to the different regions, the strongest region when it comes to order bookings are the Nordic region. We are above 100% book-to-build. We have the strongest order intake in Sweden, 114% book-to-build. And we can see a weaker order intake in Europe, especially where – and that is due to that we are more selective in the market, but it’s also due to the market itself, especially in the U.K., where we can see continued hesitation amongst the private investor but also amongst the infrastructure projects that are postponed. The decisions are postponed due to the Brexit uncertainty going forward.

I think you will see we have a healthy backlog. We also took a couple of projects recently, as we have been reported on. So overall, 13 months of production. That’s a good position.

With that, I leave it to Magnus to go into the – more deeply into the streams.

Magnus Persson

Thank you, Anders. We start with the Construction stream and an overview of the income statement here. We had revenues of around SEK 117 billion the first nine months; it’s up approximately 2% if you compare it to last year. But in local currencies, we are actually down in revenue here. That’s completely in line with what Anders just said, we’re selective in the bidding and we’re sort of focusing on the sweet spot projects here.

Operating income, SEK 2.7 billion, a significant step-up, obviously, from what we performed last year. But you have to recall, it was last year we had project write-downs and other type of nonrecurring items to the tune of SEK 2.3 billion that was charged over the first 9 months. So if you adjust back that we’re – despite that, actually coming up a bit in profitability and a bit in margin there, and that feels quite good.

If you look at the margin part, you can see the gross margin is – we increased this by 1.5%, just the comparable quarter, which is in line with the plan. And also, we have a very favorable development of S&A. But here, you need to really recall that we wrote off goodwill to the tune of SEK 400 million in the third quarter last year, and this was charged to S&A. So if you adjust for that, the actual underlying S&A last year was 4.2% instead.

So if you base it on that, you can still see that we are working quite hard with the cost level here, and we’re successfully coming down in that. And then we had a fantastic S&A level in the quarter here that maybe a bit too low on what you can expect. But still, we have the right sort of trajectory here for S&A cost. So in total, operating margin in the first 9 months, 2.3%, in line with what we see in sort of the improvement plan here.

If we look at the breakdown of the geographies then, stable performance in the Nordic, 3.7%, and 3.8% in the comparable period. But inside the Nordics, you can easily see here that there’s a shift in the composition of the performance, Skanska Sweden’s performance in Construction, 3.4%. That’s not the level that you’re used to see here. And we had a couple of quarters here with a weaker margin.

And there are a couple of reasons for this. One is that, in some cases, we finished off these projects that we have talked about in many cases, where we can release risk reserves. The profit that is one explanation, the difference. But it’s also so that we have 2 parts of the organization that are performing at levels that we’re not satisfied with. And one is the asphalt operations in Sweden and the other one is residential construction. A few projects there in the Stockholm area that have been weighing on the margin here.

In Europe, 2% margin for the first 9 months. Obviously, a lot better than the negative margin last year. On the quarter, we were in the high 3% level. And – but then you also need to remember that there’s a big seasonality in the European margin, where we essentially make all the profit in the latter part of the year, especially this is driven by the seasonality in Czech Republic and in Poland. So 2%.

And then in U.S., 1.3% margin for the first 9 months. And I don’t think I have to repeat myself again and say that we’re not satisfied with this, obviously. But we are being sort of diluted in the margin by all the debt revenue that we have to go through in order to complete the projects for which we’ve taken the write-downs before. So that is – that dilution effect is still with us, and we have guided to you before that we think we will be out of the majority of this in 2021.

Shifting to Residential Development then, also here, you can see a growth in the volume. We took in SEK 7.2 billion in revenue for the first 9 months, and the growth here is approximately 9% then. Gross income, SEK 1.3 billion. It’s a fairly big step down actually from the gross income and gross profit in the same period last year, which was SEK 1.6 billion. But we also, at that point, we’re quite open in saying that a fairly large part of the profit here that last year came from the sale of land and also from the release of risk provisions that we have been able to avoid releasing to cost, but we could release them to profit as we completed some very successful projects there.

Operating income, SEK 818 million then. Gross margin, 18%. I think that’s a very defendable level of the gross margin. S&A costs, 7%. And then the operating margin at 11.4%. And if we then look at the underlying margin, taking away the impact from divestment of land and a profit from that and also from sort of excess level of provisions. These effects now are much more normal than what we had last year. So you can say we’re still at around 10% in terms of the EBIT margin here in performance of RD, and it’s quite similar actually to last year.

If we look at the different regions, you can see Nordics, a 10.7% margin and a very high margin than last year for the reasons that I just explained. And similar for Sweden, 10% versus 17% in the same period last year. A very strong performance in Europe. And in this case, the European RD operations in the quarter are quite small in terms of volume here, but they had a fairly large release of these provisions from successful projects. So you would see a margin that is very, very high in the RD operations in RDE. And I just want to guide you that, that is not what you should be sort of looking at as an underlying performance here. A lot of that is related to release the risk provisions. But the stream level underlying is around 10%.

Starts and the sold unit, as Anders commented already, you can see the starts on a rolling 12-month basis are now below the sold units. Nothing strange with that. It has been the opposite for quite some time. We have started more units than what we have sold. And at some point, in time, this needs to balance out. We started 1,700 units approximately first 9 months, so around 1,000 units then less than what we started in the same period last year here. And the majority of the difference here is actually related to the European operations, especially in the third quarter, as you can see. Homes sold, slightly higher than last year, 2,300 units versus 2,200 units.

Homes in production, we are trending at the level now of 6,500 units in the portfolio. We have a sales rate of 70%, which is good in many ways in terms of market exposure, but it is also, I would say, on the high end of the spectrum, where we should be here. We can take maybe 60% to 70% as the reasonable level, especially now when we have the market, the consumer behavior, when they want to buy late in the later stages of the project. We need to have more inventories to sell to the market. So it’s quite natural to have lower sales right now. And against that background, the 70%, we shouldn’t really be above that. We need to watch, too, how things sell there.

And you can also see that the unsold completed is coming down quite a lot from year-end and also from the second quarter, which of course is a sign of a healthy portfolio. We’re selling what we complete there, and we’re also selling the things that have already been completed. We have a good churn of that stock of the unsold completed.

Shifting to Commercial Development then. It’s already been said, fantastic performance. Year-to-date, SEK 2 billion in operating income, which is higher than last year, and last year was a very good or a very, very good performance in Commercial Development also there. So if you add then the joint venture, we sold one property in the form of a JV in the U.S. in the first quarter, which is not added to the gain of sale in the P&L. But if you still do that, we have a gain on sale of SEK 2.8 billion here for the first 9 months. So that’s very strong level of performance.

And in terms of the unrealized and realized gains out of the portfolio, we have unrealized gains now in the portfolio of around SEK 8.4 billion. And you can see there’s a, quarter-by-quarter, a step-down here in unrealized gains. But that is simply because we now have realized it. So we have SEK 1 billion step-down in unrealized gains. We have around SEK 1.1 billion in realized gains in the last quarter. So those things go together here in a good way. And then you can track the green line, which are the gains that we are realizing on a rolling 12-month basis. So you can see that this then coming up successively also between the second and the third quarter here.

If we take the portfolio that we have of the ongoing projects, unsold ongoing projects, and we split this out and you should read this slide here as – the bars represent the investment value of the properties in the portfolio when they are completed. And the timescale is when we expect to complete the properties. And the line that you see, that is the leasing rate of these different properties. So ideally, you would have – you would like to have a high leasing rate on the properties that is soon to be completed and then a lower leasing rate as you go out in time here.

Which is more or less exactly what we see here, of course? The real life isn’t so nice as the theoretical model. But overall, we have a nice slope down of the leasing rate in the portfolio against the completion – expected completion time of the properties there. We have a bit of a weak spot in the second quarter 2020, but it’s nothing that we’re concerned about. It’s 3 properties and it’s all about when they actually approach the market to secure the leases also here.

And in terms of leasing, we had more than 200 – I think we had 260,000 square meters leased year-to-date, which is a very high number. You can see the blue bars here, where on a rolling 12-month basis, securing around 500,000 square meters of leased space. And then you can see the percent of completion and you can see the leasing rate, which represent the 2 different lines here. Ideally, they should be aligned with each other at approximately the same level and – which is what we have also now. Then you can see that they are moving up quite a lot, and that’s a sign that the portfolio is getting on the average, a bit more mature.

And the reason to that is that we have had a bit slower start on new projects, the latter few quarters there. We are fighting a bit with the external cost escalations on the construction market in the U.S. and also in Europe, which makes it tougher to make sure and make ourselves confident that we have a solid business case before we start the project. So this delays our starts, to some extent, and that is also quite evident in this chart here.

If we look at the group then, we have the income from all of the business streams I just went through, SEK 5.5 billion versus SEK 3.1 billion last year. And then we have central items, minus SEK 141 million, a very big step down from what we had last year of around minus SEK 640 million then. But then you need to remember that in the second quarter this year, we released the provision that we held centrally for what we call the R4 case in Czech Republic. And that we could release the profit, and that amounts to SEK 212 million, which we took in the second quarter.

And in addition to that, we nowadays have what we call asset management inside this central stream, and that is the former ID business stream of Skanska, they contributed with SEK 50 million here year-to-date. So you can get the comparison right.

It will take us down then to the operating income of SEK 5.4 billion versus SEK 2.4 billion. And then we have net financial items, minus SEK 69 million year-to-date. And here, we have something that is called interest costs from lease liabilities. 1st of January 2019, we, as everyone else, introduced IFRS 16 in a way of accounting for leases. And that essentially moves the interest part of the lease cost from the cost of goods sold down to the net financial line in the P&L. And that is approximately – we are trending now at around SEK 60 million per quarter in that there.

And then someone that is quick to do the math, you can see that the difference between ’18, when we did not have that cost, and ’19 is not so big, but that is because on the other part of our interest-bearing liabilities, that is not pertaining to leases. The interest cost has come down, partly because of the sort of falling interest rates on the market there.

Taxes, we’re taxed at 16.5% year-to-date, which is a little bit lower than what we’ve been used to. And also significantly lower, I’ll say, than last year. But last year, we had to write off some tax assets in Poland, as we could not make use of them for loss deductions. So that explains that. So earnings per share at SEK 10.75 million in the first 9 months of the year.

In the remaining PPP portfolio, we have 6 assets, not a lot has happened in these assets over the quarter. We see some increase in the present value from the cash flows, but this is mainly due to the time factor here than nothing else. We haven’t sold anything and we have not acquired anything.

Cash flow, minus SEK 4.5 billion. Operating cash flow for the first 9 months, lower than, obviously, by around SEK 4.5 billion than last year. And I’ll come in back into a little bit on why that is the case. Dividend and then cash flow before any change in the net debt, minus SEK 7 billion to be compared to minus SEK 3.6 billion last year. And the big swing factor in the cash flow is the net working capital, where we have had a much larger outflow now in the first 9 months this year than what we had in the first 9 months last year.

And there are a couple of things, I think, we need to recall in this. One is that 2018 was a pretty good year in terms of net working capital cash flow. Year-to-date, we had approximately 0 impact of that. And normally, the third quarter of the year, this is the quarter where we have been in full production in the Construction arm, and the cash has sort of been flowed into the projects. So that’s the low point of the net working capital, but we were at 0 last year.

And the other thing is that we have booked up these loss-making provisions that we have talked about before for when we write-down the Construction project. And what we see now is that as we are completing these projects, of course, we’re putting the cash into the projects, which is hitting the cash flow. So these 2 effects taken together explain the change in the cash flow – in cash flow from working capital here in Construction.

So why are the bars still so high up, as you can see here, because – that is because of the loss-making provisions? So when you look at the cash flow for Skanska and try to understand the net working capital contribution, you really need to look at the cash flow profile and not only the balance sheet items, which is what you see at this slide here.

Investments, divestments and capital employed. Residential Development, we’re roughly at the same level as we were in the start of the year. And for Commercial Development, as you can see, we have increased divested capital by around SEK 10 million – SEK 10 billion since the start of the year. So that’s quite a lot. And a big part of this is, of course, the production we have. And notably, the 2 big towers in the U.S. also are contributing to this.

Financial position, total assets, SEK 128 billion, and we had equity at SEK 30.3 billion. Interest-bearing net debt, minus SEK 14 billion. Looks a lot, but you have to recall that we have added here the lease liabilities, if you compare it to last year. And the adjusted net debt to minus SEK 3.9 billion, where we have said that we wish to not be below minus SEK 9 billion here. And a comfortable equity-to-asset ratio of 23.6%.

Anders Danielsson

Okay. Going to the market and the difference, starting with the Construction stream. In the Nordic, there’s quite a mixed picture when it comes to the building market, we can see a continued slow market in the residential construction, but we can see a strong – continued strong infrastructure market and also the commercial market. And the civil market, both in Sweden and Norway are good.

Finland, stable. But we do see a slowdown in the residential market in Finland. So that’s also why we report that a bit slower outlook the next 12 months. Europe, unchanged. The Brexit, as I’ve been talking about, influencing the market negatively, both in the commercial and the infrastructure market. Central Europe, stable. In Czech Republic, though, we can see a slight improvement in the civil market, and that’s due to that we can see now that more EU money coming into that market. It has been a gap between the programs, so to speak. So – but we can see a slight improvement there.

But of course, we continue to see cost escalation in Central Europe. And that influenced also, of course, we – I think it’s leveling out now. It’s not as high increase that we have seen in the last few years, but we can still see it. And the U.S. continues to be a good market, but still continuous fierce competition. But the funding is on a healthy level. And the main funding for the project, we can see in the pipeline comes from the state. So we’re not seeing so much federal money, it’s – but there’s a good, healthy level on the state level.

Residential construction – Residential Development, increasing construction costs in all our markets. So we have to be aware of that. We have to make sure we are cooperating internally in a good way to find the right solution, the right product, to make sure we have the business case secured before they start the project.

I expect the Swedish market to continue to be on a slower level. Again, I can see a stable stabilization and also in the prices in the market. Stable market in Norway. And again, a bit slower in Finland. Europe has also slowed down a bit after very strong growth the last few years, but it’s still a good demand in the market for residential.

Commercial Property Development, here as well, we can see increasing costs that we have to be very careful about in the – when we start the project. But the market is very strong. The interest is very strong from investors in all our markets, and we also have good interest from tenants. I can also comment on the U.S. market that we believe that the yield compression might have leveled out now. But it’s on a very – still a very good demand from investors there.

Summarizing the group then, the underlying profitability in construction is improving, very important. We have a strong balance sheet and we can take advantage of the changed behavior in the market, the residential development market that the buyers want to buy closer to completion. We have a continued attractive Commercial Property Development portfolio. So I’m confident with that.

We can see high market activity in many of our geography and segment, with a few exceptions in Construction. Project development, challenged by cost escalation in the construction market. We got to take care of that, address that carefully. And the execution of the strategic action we took 2 – some 2 years ago is going as planned.

So with that, I leave it to André to start the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions]

AndréLöfgren

Perfect. Thank you very much, guys, Anders and Magnus. We will start with questions from the audience. And after that, we will hand it over to the telephone conference. And I see some hands in the air already. Please state your name and where you work at. Tobias at ABG.

TobiasKaj

Yes. Tobias Kaj from ABG. I would like to start to follow-up what you mentioned on the Construction margins in Sweden that you had some problems within asphalt and in some resi project. Regarding the resi projects, are they completed? Or will we continue to see more negative effects from them? And regarding asphalt is that project specific? Or is that more a tougher market that result in lower profitability?

AndersDanielsson

I can comment on that. If we start with the residential project here in – mainly in Stockholm area, there are a few projects. Some of them are completed and some are still ongoing, but we believe, of course, that we are taking the charges that have needed to complete those projects.

When it comes to asphalt, we have made quite major restructuring of the business due to low performance for some time. And we have seen that, we believe that we should see improvement here in the third quarter, that hasn’t happened. So we have made further action on that business. We think it’s a good market. And we – historically, we – it’s a good market and good operation for us. We strongly believe that we will gradually come back to that profitability that we should see.

TobiasKaj

And regarding the cost of brands in the residential projects has that only impacted construction? Or did you see a negative impact in residential development as well due to that?

AndersDanielsson

Mainly impacted the Construction, definitely. And you can say it’s in a few projects that we haven’t had enough control of the cost, and we have seen cost increases that we should have been able to estimate before.

TobiasKaj

And within the residential development, in the Nordics and in Stockholm, the margin is clearly below the target of 10%. And within the segment reporting, most of the profit is recognized when the units are sold. Does that mean that you are now starting projects where the profitability is not reaching the 10% target? Or is it – is the lower margin more related to completed projects where you’ve had problems or needed to reduce your prices?

AndersDanielsson

I would say the underlying profitability in the order stream in Sweden is still at the 10% that we have been reporting previously.

Operator

Stefan E. Andersson, SEB,

StefanAndersson

Stefan from SEB. A few questions starting with the commercial side. I fully understand you’re not going to give me any numbers, but if you look at the 3 regions and the margin potential from them, how do they differ if you could grade them?

MagnusPersson

All right. You mean – not sure I caught you, but you mean the Nordics, Europe and the U.S., how do they differ in terms of the margin?

StefanAndersson

Exactly.

MagnusPersson

I’d say it differs much more project-to-project and what you can see, like a structure difference across the regions there. So I’m not sure you’re sort of hitting the right point. The region-by-region margin can vary quite a lot depending on what we have in the portfolio.

StefanAndersson

Okay. There is – was the strong margin in the quarter coming from Eastern European properties, primarily, it seems like you have good margins in those. But that’s property related. Okay.

When it comes to – you talked – you took a big charge for the legal discussions and so on in the U.S. or add-on jobs and so on that you didn’t know you were going to get paid for or not. Could you maybe elaborate on where you are at that? You’re hoping to get some of that back and you’re in discussions, I understand. Are you more or less positive where we stand today to retrieve some of that? And maybe some of that had already been retrieved. I don’t know.

MagnusPersson

Yes. I can start. You’re referring to the project write-downs that we were taking last year, just to –

StefanAndersson

Yes. I mean parts of it, the part that where you had claims that you…

MagnusPersson

Exactly. So some of this – some – when we claim money, this is not money that has flown out of the company yet. Then it’s often a big discussion with clients, unfortunately of late, also in the projects here to come to an agreement on who is to pay – supposed to pay for this then. And in many cases, this has to do with changes in the design that has caused disruptions in the production and also maybe additional costs related to the design. So I say, yes, some of those costs, we still expect that we could potentially recoup them. They are not lost yet. And some of them, even if we have seen the cash outflow from the company, that’s not necessarily us, recognizing that this is our fault. We can still claim the client for the money there, of course. But unfortunately, this process tends to be quite long. So there’s not a quick fix to sort of come to resolution on them.

StefanAndersson

So we haven’t seen a lot yet, and you’re still hopeful. That’s the conclusion.

AndersDanielsson

Yes.

StefanAndersson

Coming back maybe to the earlier question on residential then, the final question. Looking at the underlying margin in the quarter, adjusting for extremely high profit in Europe. It seems like the underlying – the quarter was around 7.5%, maybe 8%. Would that – if I interpret you correctly, that’s an unusually low – that’s not a normal highest level because you had this impact in Sweden. Is that correct?

MagnusPersson

Yes, that’s correct. That’s correct. I mean partly, as you know, quarter-by-quarter, this goes up a little bit all the time. So looking at one isolated quarter is a bit dangerous. But I will also say, we have this fairly big positive impact in Europe. And in the Nordics, we have almost at least a corresponding sort of impact of some projects that we take cautious profit recognition in. Which is why on the stream level, we say that the total effect of the sort of land and the provisions there is quite normal now. But that’s at the stream level. Inside that, it’s distributed in a different way.

Operator

Niclas Hoglund, Nordea Markets.

NiclasHoglund

Niclas Hoglund. Firstly, if we start out with the U.S. margin. I mean we saw, well, quarter-over-quarter, a pretty healthy development. Margin is 1.1% in the second quarter and now bouncing a little bit to 1.4%. Could you help us to sort of explain, is all of that delta related to the – that revenue fading a little bit? Or could you help us understand the sort of -.

AndersDanielsson

I can comment on that. I would say, the underlying performance in the U.S. operation is good. But we do have this dead revenue that we need to complete those projects and that will take us some time, but it’s actually fading down now quarter-by-quarter. And at the same time, we can see a good performance in the underlying business, and that’s encouraging. But it will take some time.

NiclasHoglund

And a follow-up, you mentioned the very strong announced orders in the fourth quarter, and we saw – was it yesterday, SEK 7.3 billion order in the light rail in, what was it, Washington? More civil-based, if I understand it correctly. Would you say that this is a show of new confidence in the civil market? You’re sort of highlighting the competition. You need that for more of a strategic, filling the sort of production pipeline. Or should we expect healthy profitability?

AndersDanielsson

Yes. We are very selective now when we – which geography we go for in the civil operations. We’re also very selective with type of project, which risk level do we have. Do we have the right competence in place, the right resources? And do they have the right contract, of course. And this that you’re referring to, we announced yesterday, that is the so-called ECI project. It’s early contract involvement. So we have been working with that project since 2016 in the first stage, and we have developed together with the client, the design. We have defined the cost of the project, so in the typical project that we are much more confident about the cost and about the expected profitability level.

And we do have – we have a strong presence in the West Coast and the East Coast in the U.S. for the civil operation, especially from the New York area and also from the California area. So we have also moved some strong resources to Seattle area, the Washington state area, to help them out. But they have – we do have a strong history there as well. We can – we have lately completed 3 large civil projects in that area. So it’s one of the core geographies, definitely.

NiclasHoglund

Right. And then coming back to Sweden a little bit. You talked about sort of issues in the quarter. Really looking at the rolling 12-month basis, we’re down at 3.5% margins in Sweden compared with more of – close to 4.5% over the last, well, at least 8 years since 2010. Is there any structural reason for you to sort of be on these lower levels in Sweden now, which is – well, we haven’t seen that in the past? Or should we expect a recovery?

MagnusPersson

Yes. I mean, as we said, we have issues then in the asphalt production business and in the residential construction part in Stockholm here. It’s not like these problems have suddenly materialized over the quarter. We’ve had a too low profitability by our standards in the asphalt business, for instance, for some time here that has weighed on the margin. But we have been quite convinced that we will sort of have quick return from that. And now when we have developed all the action plans and taken some of the actions here, we can see that it’s a little bit more – it will take a little bit more time to sort of get there. So hence, in the interest of being as open as possible, just defining the problem here, what is weighing on the margin?

So is it a structure problem? You see in a project-based business, you can in a way say the problem is the project. But this is not only projects in the asphalt. We have, of course, production facilities and we have – it’s more of an industrialized production in part of this. So it’s a little bit different type of problem.

NiclasHoglund

Okay. And my final question is related to the Commercial Development part. Well, you mentioned that you have a very strong pipeline. And you also mentioned 2 U.S. projects, where we sort of – well, you are investing in part of the sort of buildup of capital employed with SEK 10 billion. There are media speculations on those U.S. projects and also on a large Swedish project that are being finalized now in the fourth quarter. What is the sort of expectation of divestments? And what should we expect from that?

AndersDanielsson

Yes. We don’t give any forecast when we are planning to divest a project. But I can tell you, we’re in good shape. We’re in good shape in those projects, both when it comes to leasing and completion. And so we – I can guarantee you; we will communicate directly when we have some good news there. But we’re in good shape.

NiclasHoglund

And then a follow-up, normally or at least going back in time, there’s always been a tendency for healthy divestments towards the end of the year. Is there any reason to expect that to be different this year?

MagnusPersson

It’s a very leading question, Niclas. But a good try.

Operator

Albin Sandberg, Kepler Cheuvreux.

AlbinSandberg

Albin Sandberg, Kepler Cheuvreux. I have three questions, please. The first one, could you just update us on the net working capital situation so I fully understand that? You referred to that all the way in the – at the Capital Markets Day that you were expecting potential SEK 5 billion outflow. I understood it partly because of your downscaling of projects, but it seems like, not at least with these 2 projects that you’ve announced now for the last 2 days that you still grow the business when you can. So are those SEK 5 billion still relevant? And how much of that have we already seen now as of Q3?

MagnusPersson

Yes, the SEK 5 billion are still relevant. I think a testament to that is that when we communicated the SEK 5 billion, we had a very good run on net working capital for 2018, which was the basis for that discussion. Now we are in Q3, the year after, and we see that we have a significantly lower net working capital position – or significantly worst cash flow from net working capital. So I think in a sense, it confirms the view that we have that we need to stay on our toes in terms of where this is going here. And how much of that is consumed, I can’t really answer that. But I think the important part here is to look at the cash flow and not sort of blindly look too much at the balance items of the working capital. It’s the cash position that we want to have there.

AlbinSandberg

And then could you just could help us understand also the comments you’re making about, on the one hand, cost escalation and at the same time a bit slower market outlook. Is it just the late cyclicality of input costs? Or are there any structural reasons for input costs coming up, such as lack of resources? Or if – I guess, if market outlook goes down, I would have guessed maybe the outlook for cost input should come down as well. Or maybe that’s not the case.

MagnusPersson

Of course, it’s quite natural when the market goes down; we can see quite quick cost decreases amongst suppliers, subcontractors and so on. So that for sure will happen. But to date, we have not seen that yet because the market is still very overheated in Central Europe, for example. The unemployment rate is on a historically very low level. So we do see pressure still on cost upwards. But of course, that will sometimes level out, and we can see that leveling out now in – especially in Central Europe.

AlbinSandberg

And then my final question on the Commercial Property side and maybe referring to the Stockholm one project. I mean some of your property peers so far in Q3, there has been some report about potential weakening demand for tenants. Is that something you see? Or do you feel that the outlook is as strong as it was after Q2 or Q1?

MagnusPersson

No. We think we still have very good demand from tenants on our properties. We don’t see any weakening demand really.

AndréLöfgren

All right. Any more questions from the audience? No? In that case, we will move over to the telephone conference. And please follow the instructions.

Operator

Our next question comes from the line of Simen Mortensen from DNB Markets.

SimenMortensen

This is Simen from DNB. I have 2 questions for you guys. I was wondering if you can, first off, give us an update on the PPP portfolio. It’s still a huge value in the balance sheet but little comments in the report. How are you progressing with sales and divestments in that portfolio?

MagnusPersson

Simen, this is Magnus here. Thank you for your question. You asked for an update on the PPP portfolio, we have essentially 3 projects in the – so 6 projects in the portfolio, of which 3 are sort of completed in Construction. And we will, of course, communicate not when we go in and start the divestment process but at the time when we have an agreed contract with someone to sell the asset there. But the plan is still – this is a run-off portfolio; we will complete all of these assets and then we will put them to the market after the ramp-up period and when we have exited the equity lockup period.

SimenMortensen

So no guidance on time line, on realization of that portfolio?

MagnusPersson

Sorry, I didn’t catch that Simen. Can you try again?

SimenMortensen

So when are you completing these projects?

AndersDanielsson

When are you completing the projects?

MagnusPersson

When we are completing the projects, we are completing the construction works. The last project in the portfolio in terms of construction completion is ’21, ’22.

SimenMortensen

Another question comes down to residential development. I do see that the plot values in the balance sheet are increasing quite significantly. It’s now at SEK 8.4 billion, it’s up roughly SEK 2 billion in 2 years, 35% in 3 years, continue to take up more capital. How much are these more expensive plots – if that is impacting the RD margins? Or is there something else that is the reason that the RD margins are coming down?

MagnusPersson

We have a hard time understanding you, Simen. Can you speak up or speak even more clearer? SEK 8.4 billion we caught.

SimenMortensen

Yes. The plots in RD are up significantly year-on-year, SEK 1 billion it has been growing annually for the last 3 years. How much of this is a cost element versus a volume element in your land bank?

MagnusPersson

Are you asking about stocks? Or what number are you asking about, Simen?

SimenMortensen

The plots in residential development.

AndréLöfgren

The land bank.

MagnusPersson

Plots. The land bank, yes, thank you. Volume will increase prices that are driving the growth in the land bank. I think that’s a very good question. Of course, we’ve had a favorable economic situation in most of our markets for quite some time, and that is driving land prices up. There’s no question about that. Then where we are now, I’d say we have, in some places, we have a land bank that might be a bit too big, to be frank. And in some places, we have a land bank that might be a bit too small. I think on the average, we have a land bank that is quite defendable given the sort of volume ambitions we have.

Operator

And as we have no further questions from the telephone lines, I’ll hand back to the speakers in the room.

André Löfgren

All right. Thank you very much. Then we’re done for today. And yes, happy Thursday to you all.